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'Bleeding Kansas' a worry for muni investors

Feb 3, 2013 @ 12:01 am

By
Bloomberg News

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Sam Brownback(Bloomberg)

Kansas Gov. Sam Brownback has a prairie-wide smile, a friendly manner and an abiding hatred of his state's income tax. He pushed an unprecedented cut for individuals and small businesses through the Legislature last year and is now plotting, as he says, to “take it to zero.”

Neighboring states in the nation's sprawling midsection have taken note and are moving to piece together tax cuts, lest Kansas lure away jobs — which is exactly what Mr. Brownback, a first-term Republican, wants to do. At least eight governors last month said they want to cut or eliminate their levies.

“Kansas is the starter gun for tax competition,” said Grover Norquist, president of Americans for Tax Reform, which is pressuring members of Congress to sign a no-tax-increase pledge. “Brownback fired off the shot that said: "Go.'”

The race presents significant hurdles. Kansas lawmakers haven't figured out how to pay for the tax cuts without potentially crippling public schools and other local government functions. Reducing the income tax has left a projected $2.5 billion revenue hole through fiscal 2018, according to the Kansas Legislative Research Department. A state court ruled Jan. 11 that the Legislature was illegally underfunding schools, and ordered a payment of $440 million.

“It's a major fiscal risk,” Chris Mier, managing director of analytical services at Loop Capital Markets LLC, said of Brownback's income tax push. “Are the alternative revenue sources going to produce the revenue they need?”

BOND PENALTY

Other investors share his skepticism. Kansas issuers performed poorly in the $3.7 trillion tax-exempt market during the past year. The bonds' 5.5% return in 2012 was the eighth-worst among all U.S. states, beating only Connecticut, Delaware, Maryland, New Mexico, North Carolina, Utah and Virginia, according to Barclays PLC data.

Moody's Investors Service said Jan. 17 that the school-funding ruling represents a negative-credit risk for the state and “underscores the challenge” confronting Kansas to offset the revenue loss from the income levy reductions.

Mr. Brownback and other Republicans share the bedrock belief that eliminating income taxes will spur economic growth that would make those levies unnecessary. Texas, one of seven states that don't have a levy on wages, is held out as the example of how growth thrives when income isn't taxed.

“What this is, is a plan, a strategy that gets us to job growth,” Mr. Brownback said in an interview Jan. 24 in his office in the Capitol. “I'm tired of losing jobs to Texas, so all right, let's start fighting with them. That's what we're doing.”

Critics contend that education and other government services are important components of economic development and are at risk under the governor's plan. Texas has the good fortune of living on an ocean of oil, they note, and argue that Mr. Brownback's belief in the power of tax cuts is misguided.

“In the governor's mind, if you take two and subtract one, you come up with three,” said Kansas State Rep. Nile Dillmore, a Democrat from Wichita. “It just doesn't add up.”

The top Kansas income tax bracket dropped Jan. 1 to 4.9%, from 6.45%. The change also eliminated taxes on almost 200,000 small businesses.

Mr. Brownback went further in a Jan. 15 speech to lawmakers, calling for more cuts in 2014, 2016 and 2017. To help pay for it, he proposed eliminating some tax exemptions and making permanent a temporary 1-percentage-point increase in the sales tax, which was enacted in 2010. The higher sales tax isn't popular among some Republicans and interest groups.

30 YEARS OF SPENDING

Mr. Brownback said 30 years of spending hasn't improved the state of 2.9 million people, with its long history of political struggle. Nineteenth-century slavery battles with neighboring Missouri earned the state the moniker “Bleeding Kansas.” Topeka schools were one of the defendants in the landmark 1954 Supreme Court decision Brown v. Board of Education, which outlawed racially segregated schools.

But the consequences of cutting taxes bothers more than Mr. Brownback's opponents. Don Hineman, a Republican House member from the Western Kansas town of Dighton, compared the state-versus-state tax battle to an arms race.

“Everybody's racing to zero, and then we lose that advantage,” he said. “It becomes a zero-sum game.”